To let or to pre-let?

To let or to pre-let?

Nick Coote

Despite the economic climate, companies requiring a larger office building are still more likely to procure it via a pre-let agreement than by taking existing office space.

However, when you consider the rules and regulations governing occupiers’ corporate real estate accountancy protocols, this is perhaps not surprising. How are corporate real estate accounting laws impacting office acquisitions?

Nick Coote, Director in our Office Agency team, explains why.

Few companies digilently comply with legislation

Pressure comes from the International Accounting Standard 37 (IAS 37) and the Financial Reporting Standard 12 (FRS 12). These dictate that a company’s financial accounts should provide an accurate assessment of the provisions it needs to make to cover the liabilities of non-operational property leases.

Worryingly, research suggests that few companies diligently comply with this legislation, and are therefore not showing the true impact of non-operational property on their business.

Corporate occupiers to change their approach

For some occupiers, the buoyant property market of earlier years virtually negated the need to proactively manage surplus property as property; disposals and sub-lettings were easily secured, and therefore costs and associated liabilities were limited. However, as the impact of the credit crunch continues to cause turmoil, a vacant and non-operational leasehold property that is surplus to requirements, and where there is no sub-let agreement in place, is a significant problem.

This situation fulfils the criteria of an ‘onerous lease’ and must be reported in a company’s accounts, with the provision accounting for the total disposal cost of the lease.

The impact of legislation on property procurement

With an impending lease end on an early/mid 1980s office building, a company will take one of four options, the first being to stay where it is and re-gear the current lease. However, given the age of the building, it is inevitable that M&E systems will need replacing with the building itself requiring a major refurbishment. To continue an operational business amidst these extensive works would be nigh on impossible, causing significant disruption to staff and revenues.

An alternative would be to wait until the lease end is a matter of months away before entering negotiations to occupy an existing office building. However, it’s highly unlikely that the exact size, location and layout of building will be available to satisfy exact requirements, let alone a building that is ready to be occupied at the eleventh hour. The associated risks to business continuity are not worth taking, as this option could well leave an occupier out in the cold in an already uncertain market.

Respond early to lease events

With these issues in mind, it is imperative that an occupier takes action on a lease end around two years prior. However, signing a new lease on an existing office building at this stage means that rent and other liabilities on the old premises will run concurrently with those of the new building.

Furthermore, while the occupier may receive a landlord’s incentive to acquire their new property, this credit must be amortised (diluted) over the length of the new property lease. The result of capitalising costs and amortising (diluting) incentives is likely to have a negative impact on a company’s current balance sheet, meaning that this option is often, unsurprisingly, resisted by the FD.

Pre-let agreements offer flexibility and choice

The final, and more viable, option is to sign a pre-let agreement at this two year mark. This approach reports a very different story: there is adequate time for a developer to build the property, with design, internal layout and fit-out built to accommodate the occupier’s specific requirements.

Most critically, the terms of the pre-let can predetermine a lease start date that dovetails with the impending lease end. The result? Minimised onerous lease liabilities and a modern HQ building that is tailor-made for an occupier’s business.

For further information relating to this news article contact Nicholas Coote